Tuesday, February 07, 2006

The Safety Net

Let's start neither with the Tradeplan nor Money Management. Both are essential for a trader, but of even more importance for a struggling trader is the Safety Net.
You can't trade without sufficient funds in your account. As a trader, especially as a greenhorn trader you will suffer losses. And at times you will not be able to control these losses, you will let them go out of hand. Reading about Market Wizards you will notice, that most admit to have gone broke at least once, but most usually a few times before they were able to make it.
My all time favorite is still Reminiscences of a Stock Operator from Edwin Levevre and if you haven't read one book about the markets, that's the one book you have to read. It's the classic trading book and it's lessons are as valid today as they were valid 100 years ago.
All these traders first made thousands from the market and then lost them all again. But they had made sure one thing: Usually they had some cash aside to be able to start again.

Treat trading as any other profession. Learning to trade will cost you tuition. The only difference to a regular tuition is, that you can fix the amount you are willing to pay within certain ranges. Accept this fact and prepare for it in advance.

Say you have a 10,000$ account to start trading. I know that's not a lot, on the other hand, you can buy really nice things for 10,000$ so it's sure not nothing. You can't start daytrading stocks with 10,000$ but you can start trading futures with this amount. Actually margin rules allow you to trade with a lot less due to the high leverage futures give you.

Taking this fact into account let's build our safety net with our 10,000$ account. IB (Interactive Brokers) with whom I'm not afiliated other than that I trade with them for 4 or 5 years now, allows you to trade futures if your account has at least a value of 2,000$.

So, if you intend to embark on the road to trading success, split your 10,000$ in two accounts. One account will get funded with 3,000$ the other with 7,000$. Your 7,000$ account will sit just there, earn interest and be your Safety Net. And you will trade with your 3,000$ account only.

Of course you intend to build your 3,000$ account and if everythings run smoothly, you will not need your Safety Net. But in case the S**t hits the fan and you let your account dive below 2,000$ and to make matters worse, not you but IB pulls the trigger and get's you out of the market, because your account became undermargined, you have your Safety Net ready and waiting.

Take a deep breath, make a strike on the I have gone broke board, take a day or two off, think about the reasons why you were not able to act and save your account from going under, and then submit funds from your Safety Net account to your trading account, stand up and continue your education.

I can guarantee you, that after going through this experience once or twice, you will have learned a lot about yourself and about trading, you will have saved yourself a lot of money and you will have cash available when you are really ready to trade.

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